Time is ticking

2Q07 results hit by dilution. Higher office rental revenue (+23%) from both Suntec and Park Mall, with higher occupancy and rental rates as well contributions from Suntec Strata acquisitions and muted retail rental revenue (+0.9%) supported the growth in gross revenue and net property income of 8.1% and 10.3% respectively. Distribution income grew 19.3% yo-y, delivering 2Q07 DPU of 1.965 cents which translates to DPU yield of 3.9%. With the recent private placement of 120m new units (net proceeds of S$176.6m) to fund the buyback programme for Suntec strata units, there was a dilutive negative impact from a larger unit base in the absence of yield accretion coming through with only 30,172 sf of Suntec office strata space (S$40.7m) acquired to date. As such DPU growth of 8.5% y-o-y did not keep pace with growth in distribution income, and was below expectations.

No acquisitions, but value of portfolio value grew. Along with its 2Q07 results, Suntec has revalued its portfolio upwards by another S$613.6m, mainly attributed to Suntec City (office +30%, retail +14%) in addition to the Suntec Strata space buyback which raises portfolio to S$3.8bn and reduce debt to assets ratio to 23.3% from 27.7% in 1Q07, further increasing debt headroom for acquisitions. Accordingly, NAV per unit is raised to S$1.80, from S$1.43 in FY06. Moving forward, we continue to see Suntec as a strong beneficiary of asset reflation, backed by strong rental growth. However, we are cautious on prospects of acquisitions for Suntec, as the strata buy back programme is not gaining pace. Office capital values are on the rise, compressing physical yields with immediate yield accretion prospects looking increasingly remote.

Office rents continue to surge by 20%, within expectations. Office rents in Suntec City continue to surge, achieving rents of S$8.00-S$9.50 psf from S$6.50-S$8.00, within expectations. We reiterate that Suntec continues to be a beneficiary of spillover demand from tight vacancy and bullish rentals in the CBD spilling over to secondary locations.

Maintain Buy, TPS$2.20. While time is ticking with dilution from deferred units soon to take effect in FY08, strong positive rental reversions are expected to outpace the negative effects of dilution for Suntec’s distribution income which we have factored into our DCF projections. Despite the lack of visibility on acquisitions without the backing of a developer sponsor, i) asset reflation remains a key theme for Suntec, ii) retail enhancements well under progress iii) beneficiary of circle line – once completed in 2010-2011 for both the Suntec office and retail portfolios iv) kicker in traffic flow with Singapore’s position as major MICE hub and Integrated Resorts. With target price of S$2.20 backed by DCF valuation unchanged, we maintain our Buy recommendation on Suntec.

Valuations are not compelling

Results are in line. Suntec REIT reported 2Q07 revenue of S$46.6m; +8% YoY and +2% QoQ. Distributable income was equally strong at S$28.0m; +19% YoY and +4% QoQ. At the DPU level, growth was more moderate at +9% YoY and +4% QoQ to 1.965 cents. Growth was mainly due to the increase in office revenue at Suntec City and Park Mall offices as well as the newly acquired strata space from Suntec City and good cost control. While property expenses rose 2%, this was much lower than the rate of increase in revenue and this explains the stronger bottom-line performance. Cost to income ratio fell from 26% (2Q06) to 24% in 2Q07. The results are in line with our estimates.

Outlook remains positive. Suntec continues to benefit from the buoyant office/retail market. Over the period, its office portfolio achieved an occupancy rate of 99.2% (Suntec at 99.3% and Park Mall at 98.1%). Going forward, a substantial portion of its space is coming up for renewal and this should boost organic growth over the next 2 years.

Reinstatement of acquisition fees to manager. In Aug 2005, Suntec’s manager ARA Trust Management (ARA) waived its acquisition fees entitlement to show its commitment to the long term interest of unitholders. In Feb 2007, ARA announced that it will be reinstating the 1% fees for new acquisitions. In terms of impact to unitholders, we see this additional cost as marginal and should not have any meaningful effect on the accretion assessment of any new purchases. Since Dec 06, Suntec has bought about 30,172 sf of strata space at Suntec Office Towers at an average cost of $1,349 psf or a total of S$40.7m. We do not see any funding issue, as Suntec’s earlier placement raised about S$177m. We estimate over 1.0 m sf of strata space not owned by Suntec, but it is difficult to assess whether Suntec will be able to acquire the remaining space as ownership is very fragmented.

Maintain HOLD. Suntec is trading close to our fair value of S$1.82 (based on asset size of S$4.5bn versus current asset size of S$3.9bn) and with its trading yield at about 4% and with no acquisition pipeline, the investment case for Suntec is not compelling. We thus maintain our HOLD rating on Suntec.

CityDev, Suntec Reit settle $788m dispute

CITY Developments (CityDev) and Suntec Reit have settled their dispute over an aborted $788 million property deal.

In 2005, CityDev rejected Suntec Reit’s move to terminate the deal under which Suntec Reit was to have bought 11 properties from CityDev for $788 million. Suntec Reit called off the deal on grounds that it could not obtain regulatory approvals in time to convene an extraordinary general meeting of unit-holders.

Yesterday, Suntec Reit trustee HSBC Institutional Trust Services (HSBCIT), Suntec Reit manager ARA Trust Management and CityDev and its subsidiaries entered into a settlement agreement under which HSBCIT will get a refund of $5 million, being the total of various deposits it made. CityDev will be paid all the interest earned on each deposit. The payments are expected to be made to HSBCIT and CityDev by tomorrow.

The parties said that the terms of the settlement agreement constitute full and final settlement of the matter without admission of any liability by the parties.

Valuation not compelling

Results are in line. Suntec REIT reported its 1Q07 revenue at S$45.9m; +16.5% YoY and +2% QoQ. Distributable income was equally strong at S$27.0m; +21.7% YoY and +9% QoQ. DPU came in at 1.963 cents; +14.5% YoY and +8.5% QoQ. Growth in earnings was mainly attributed to the acquisition of 12,045sf in Suntec strata office space. This was supplemented by higher rentals from increased office occupancy at Suntec City, higher passing rents of retail space as well as additional incomes from more intensive use of space. Suntec also managed its cost well with cost to income ratio at 24%, as compared to 28% in 1Q06 and 25% in 4Q06. The results are in line with our estimates.

Outlook remains positive. Suntec continues to benefit from the buoyant office/retail market. Going forward, a substantial portion of its space is coming up for renewal. Suntec’s office portfolio will see about 16% of space up for renewal in 2007, and a further 32% leases up for renewal in 2008. For the retail side, about 16% of space is up for renewal in 2007 and a further 34% of space is up for renewal in 2008. All these renewals are likely to be the key drivers to earnings over the next 2 years.

Continues to acquire strata space. Last year Suntec revealed its intention to acquire all the strata office space that it does not own in Suntec City. To date, it has bought about 26,426 sf of the strata space at about $1,335psf, which has a total value of S$35.5m at property yield of about 4.4% (assuming no gearing). We believe there is no financing issue, as Suntec had earlier placed out about 120m new units at S$1.50. It potentially has a war-chest of about S$300m, assuming that it gears up to 40% for the new acquisitions. Assuming that it manages to buy more space at the same value (i.e. S$1,335psf), we estimate it can acquire about 197,752 sf of space. The issue is whether strata owners are willing to sell out. We estimate there to be over 1.0 m sf of strata space not owned by Suntec.

Raised fair value to S$1.82. In light of the recent high valuation achieved for office and retail space, we have revised up our fair value for Suntec from S$1.57 to S$1.82. At current trading range, the investment case for Suntec is not compelling; its price to book ratio is 1.33 times, and DPU yield is just above 4%. Thus, we maintain our HOLD rating on Suntec.

Its office story has been fully priced in

● SUNT is favoured for its exposure to the rising office market given that 87% of its office leases are due for renewal in FY07-09, of which close to 91% of leases up for renewal are paying ~S$4.10psf against the recently achieved S$6.50 – 8.00psf.

● SUNT purchased 2.5% of its 1.05mn sq ft of Suntec office strata unit acquisition target at a 5% property yield. In our forecasts, we have assumed the entire 1.05mn sq ft to be purchased by end-FY2010.

● The first instalment of 34.5mn of the total 207mn deferred units, part of its purchase settlement at IPO, is due in June 2008. As the deferred units are not subject to any lockup period, there could potentially be a share overhang. Including the deferred units, SUNT’ DPU yields are lower at 3.7-4.4% versus the 4.3-4.8%.

● Our new target price of S$1.81 is based on a lower FY07-09 average required yield of 4.2%, and is supported by our DCFvalued NAV of S$1.74 or S$1.55 on a fully diluted basis. Downgrade to a NEUTRAL from Outperform.